PROJECT

On

Relationship between Mutual Funds, GDP,

GNP, Domestic Savings and Net Inflow of
Foreign Portfolio in Pakistan during the
period
1997 – 1998 to 2006 – 2007

Supervised By:
Sir Asif Mehmood

Submitted By:

Shujaat Ali – 9051

MBA (Finance)

Department of Business Administration

IQRA University, Peshawar Campus
Session 2007 – 2009

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CHAPTER – 1

INTRODUCTION OF THE STUDY

1.1 INTRODUCTION

Mutual funds enjoy strength because of enough availability of

professionals, ability to diversify, the consistent market research &
analysis adopting the matching concept of Risk & return and large
liquidity. An average investor might not be well versed with the capital
market, or perceiving the same as more technical or time consuming in its
nature. Investment in Mutual Fund at USA is popular in the masses and
80 Million plus people are connected with the same.

In an environment where investors and savers lament the lack of

investment options, financial savings in the economy do not show an
encouraging growth pattern, and a minimum rate of return on savings
deposits has been implemented by the central bank to encourage savings,
the exponential growth of mutual funds in recent years has served to meet
these very needs by mobilizing savings and providing lucrative investment
options to both retail and institutional investors. The mutual funds
industry, which started out in the 1960s with two state ‐owned funds,
National Investment Trust (NIT) and Investment Corporation of Pakistan
(ICP), is now a thriving segment of the financial sector, with an
astonishing growth in both numbers and volumes, particularly since FY03.
As of end‐June FY08, there were 95 mutual funds on offer, with total Net
Assets of Rs. 330 billion, in comparison with Rs. 24.8 billion in FY02.
These mutual funds are managed by 39 licensed asset management
companies, equipped with the requisite professional expertise to manage
these funds.

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Since equity funds dominate the industry, growth in NAV is directly
attributable to the consistently strong performance of equity markets in
recent years. Some asset management companies have also introduced
other types of funds to cater to a wider variety of investor preferences.

1.2 BACKGROUND

In Pakistan, the evolution of Mutual Funds dates back to 1962, when the
public offering of National Investment Trust (NIT) was initially made
which is an open-end mutual fund. After 04 years i.e. in 1966 another
fund namely Investment Corporation of Pakistan (ICP) was established.
Since then ICP had been carrying the legal mandate, thus was free to
offer, a series of closed end mutual funds. Up to early 1990 this
institution had floated twenty six (26) closed-end ICP mutual funds. The
further journey of ICP ended in June 2000 during the revamping cum
restructuring-drive of the Govt. organizations , autonomous bodies &
corporation by the then caretaker Finance Minister Mr.Shoukat
Aziz.Revitilizing the privatization Commission of Pakistan the
Government started privatization of the ICP. Thus 25 out of 26 close-end
funds of the same were split into two lots. There had been a competitive
bidding for the acquisition of funds by various parties. Management
Right of Lot-A comprising 12 funds was acquired by ABAMCO Limited.
Later on out of these 12 the first 9 funds were merged into a single close-
end fund and subsequently were renamed as ABAMCO capital fund,
except 4 t h ICP mutual fund. The main known reason of not renaming the
4 t h ICP fund is the certificate holders of the same had not formally
approved the proposed scheme of the arrangement of Amalgamation into
ABAMCO capital fund in their extra ordinarily general meeting held on
December 20, 2003. The fund has therefore been recognized as a separate
close-end trust and named as ABAMCO growth fund. Rest of the three
funds were merged into another single and named as ABAMCO stock
market fund. On the other hand the Lot-B was comprised of 13 ICP

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 funds, for all of these thirteen funds, the management Right was obtained
by PICIC Asset Management Company Limited. All of these thirteen funds
were merged into a single close-end fund which was renamed as “PICIC
Investment Fund”

1.3 PROBLEM STATEMENT

The problem statement for this research is that “What is the Relationship
(Positive or negative) between Mutual Fund and GDP, GNP, Gross
Domestic Savings and Net inflow of Foreign Portfolio?”

1.4 RESEARCH DESIGN

1.4(1) the main Objective of the Study are:

The main objective of the study includes;

1. This research looks at the performance of Pakistani mutual funds
industry over a span of ten years period from 1997 to the year 2007.
2. The main objective of the study is to find the relationship among
mutual fund with four independent variables i.e. GDP, GNP, Domestic
saving and net inflow of foreign portfolio investment in order to know
whether there is a significant relation?

1.4(2) Scope of the study

The scope of this study is narrow, because we have select the duration
only ten years, i.e. 1997 – 2007, for checking the relationship between
mutual fund and GDP, GNP, gross domestic savings and net inflow of
foreign portfolio.

1.5 RESEARCH METHODOLOGY

1.5(1) source of data

Since, we are going to check the relationship between mutual funds and
GDP, GNP, gross domestic savings and net inflow of foreign investment,

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this study is purely based on Secondary Data collected on annual basis
from different mutual funds in Pakistan. So the source is secondary in
nature.

Secondary Sources:
 Official website of MUFAP
 SBP annual report
 Planning and Development Commission of Pakistan
 Books
 Journals

1.5(2) Limitation of the study

As common to every study, this particular research also had to go through
certain limitations:
• The time limitation was the biggest hurdle in the study.

1.6 SCHEME OF STUDY

The scheme of study of the report is as under:

Chapter - 1: INTRODUCTION OF STUDY

• Background
• Objective
• Scope
• Research Methodology
• Scheme of Study

Chapter - 2: LITERATURE RIVEW

This chapter includes the literature review for the research.

Chapter – 3: MUTUAL FUNDS, GDP, GNP, GDS, NIFP

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Introduction to Mutual Funds, GDP, GNP, Gross Domestic Savings and
Net Inflow of Foreign Portfolio are discussed in this chapter.

Chapter – 4: RESEARCH METHODOLOGY

This chapter discusses the methodology for the research adopted.

Chapter - 5: DATA ANALYSIS

This chapter discusses the data analysis and interpretation of the results

Chapter - 6: FINDINGS & CONCLUSION

Based on data analysis and interpretation of results findings and
conclusion are discussed in this chapter.

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CHAPTER – 2

LITERATURE REVIEW

This chapter provides review of studies conducted on the performance

evaluation of mutual funds industry.

Cheema, Moeen and Sikander (2007) further advances the argument that
institutional investors, with special consideration to mutual funds has a
great potential to augment the corporate governance in emerging
economies. The regulatory framework & mechanism needs to be
restructured in a manner that would encourage the growth of the mutual
fund industry and enable it to play a nippy & upbeat role in corporate
governance matters. The paper reviews the regulation of mutual funds in
Pakistan in the light of the above propositions which is “The Role of
Mutual Funds and Non-Banking Financial Companies in Corporate
Governance in Pakistan.”

Sipra (2007) agrees that Mutual Funds are the most popular vehicle of
investing in the stock market and their performance evaluation is a theme
comparatively dear & easier both to/for the investors and researchers in
the field of Finanace. Astoundingly, mutual funds have not played a very
imperative character in Pakistani stock market and conceivably more or
less nothing has been in black and white about their performance in any
journal. The paper looked at the performance of Pakistani mutual funds
over the span of last five and ten year’s periods up to 2007. Sharp, Jensen
and Tenor measures of portfolio performance analysis had been utilized
therein. Both the performance of Mutual Funds & that of the market
portfolio defined as the Karachi Stock Exchange( KSE) 100 were
comparatively analyzed taking the later as the benchmark for the same,
by means of the Sharpe method giving the significant results that the
performance of practically all the funds was originated to be inferior to

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that of the market portfolio. The Jensen and Treynor measures showed
about 50% of the funds to be outperforming the market portfolio over the
last five years, but when the risk measure was corrected via Kama's net
selectivity measure the market portfolio outperformed all the funds except
one. These results supported the semi-strong form of market efficiency
hypothesis even more strongly than it has been demonstrated in the
developed markets.

Aziz (2007), Mutual Fund is an institution established with the aim of

investing a pool of funds in various type of Securities with the sole
objective of benefiting all the stakeholders. Due to the involvement of
technicalities in the research activities there in capital market and
selecting the low-risk investment portfolio at a relatively meager
magnitude of investment, many investors opt for placing & diversifying
their funds indirectly, mostly in capital markets through Mutual
Funds/Asset Management Companies having expertise of portfolio
management personnel. The "Portfolio Manager", has the prime
responsibility of extensive & consistent research in the dynamic
secondary market unmistakably identifying the investment opportunities
which can convince the aspiration of the investors.

Bams (2004) put forwards a synopsis of the Mutual Funds & Investigated
via a survivorship bias controlled sample of 506 funds from the five most
important countries of Europe. He had done another analysis using the
Carhart (1997) asset-pricing model of 04 Factors. Besides that they also
logically investigated that whether fund managers of Europe put on
display 'hot hands', attentiveness in performance. Finally the weight of
fund characteristic on risk adjusted performance is well thought-out. Their
overall fallout suggest that in European market for mutual funds, and
above all small cap funds are proficient to add value, as indicated by their
positive after cost intercepts. If on addition of some management fees,
four out of five countries exhibit significant out-performance at an

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aggregate level. Finally, they detected strong persistence in mean returns
for funds investing in the UK. Their result deviate form most US studies
that are of proposition that mutual funds under-perform the market to the
tune of expense they charge.

Malkeil and Radisich (2001) are of logical& cuasal findings that index
funds are consistently producing rates of return in excess of those
dynamic funds by 100 to 200 basis points per annum in the USA over the
decade of 1990s .They in-fact found two reasons for surfeit performance
i.e. by passive funds management fee and trading costs concerned .

Warmers (2000) carried out a research on mutual funds performance in

USA and found that fund hold stocks can out perform by market @1.3%
per year, while on further investigation their net result under perform by 1
%. Out of this 1.6 % is due to expense and transaction cost related to the
same investment.

Blake and Timmermann (1998) from the U niversity of California upon the
empirical analysis of performance of UK mutual funds concluded that the
average UK equity fund appeared to under perform by approximately 1.8
% per annum on risk adjusted basis. The authors are also of the stronger
proposition that there is also some indication of diligence of performance
on standard, a portfolio comprising of the traditionally & relatively best
performing quartile of mutual funds performs superior in the succeeding
period than a portfolio Composed of the historically worst performing
quartile of the same.

Grinblatt and Titman (1992) analyze performance of 279 funds over the
period of 1975 to 1984 using a benchmark technique and find evidence
that performance differences between funds persists over time. Hendricks,
Patel, and Zeckhauser (1993) study 165 no-load growth-oriented funds
over the period 1974 to 1988 and obtain similar results. In a study of 728

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mutual fund returns over the period 1976 to 1988, Goetzman and Ibbotson
(1994) find that two-year performance is predictive of performance over
the successive two years. Volkman and Wohar (1995) extend this analysis
to examine factors that impact performance persistence. Their data
consists of 322 funds over the period 1980 to 1989, and shows
performance persistence is negatively related to size and negatively
related to levels of management fees.

Carhart (1997) shows that expenses and common factors in stock returns
such as beta, market capitalization, one-year return momentum, and
whether the portfolio is value or growth oriented "almost completely"
explain short term persistence in risk-adjusted returns. He concludes that
his evidence does not "support the existence of skilled or informed mutual
fund portfolio managers" (Carhart, 1997, p. 57). In the Kahn and Rudd
1995 study of 300 equity funds and 195 bond funds between 1983 and
1993, only the bond funds show evidence of persistence. In an article in
this issue, Detzel and Weigand (1998) use a regression residual technique
to control for the effects of investment style, size and expense ratios.
They find, after controlling for these variables, no evidence of
performance persistence.

In Gruber (1996) in his article based on USA data claims that most of the
older studies are subject to survivorship bias. When this effect is adjusted,
is argued that mutual funds on average under-perform the market proxy by
the amount of expenses they charge the investors.

Otten and Bams (2002) Maastricht University, in 2002 carried a research

on European mutual funds. Results suggest that Europeans mutual funds
especially small capitalisation funds are able to add value. If the
management fee is added back, some exhibits significant out performance.
The author also pointed out that European mutual funds industry is still
lagging behind the US industry both in total assets size and market

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capitalisation.

Malkiel and Radisich (2001) finds that index funds have regularly
produced rates of return exceeding those of active funds by 100 to 200
basis points per annum in the United States over the 1990s and find that
there are two reasons for the excess performance by passive funds:
management fee and trading costs.

In 2002 Research conducted by Bauer, Koedijk, and Otten (2002) using an

international database containing German, UK and US ethical funds
remarked that the existing empirical evidence on US data suggests that
ethical screening leads to similar or slightly less performance relative to
comparable unrestricted portfolios.

Evidence on the performance of ethical mutual funds is mostly limited to

the US and UK markets. For UK market four influential papers appeared
during the last decade. The early studies compared ethical funds to market
wide indices like the FT all share index. Using this methodology Luther,
Matatko and Corner (1992) investigated the returns of 15 ethical unit
trusts. Their results provided some weak evidence that ethical funds tend
to out perform general market indices.

In 2004, Otten and Bams (2004) in article titled “How to measure mutual
fund performance: economic versus statistical relevance” says that the
majority of US studies conclude that actively managed portfolios, on
average, under perform market indices. He quoted the examples of the
studies conducted by Jensen (1968) and Sharpe (1966). He argued mutual
funds under perform the market by the amount of expenses they charge the
investors.

Shah and Hijazi (2005) Mutual Funds, which are actively managed,
generally under perform the market on average. This trend is more visible
in the money market funds where difference between market return, risk

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free rate and fund performance is in the range of 1%. The low risk nature
of these investments as compared to equity funds result in lower return
which in turn leaves little or no room for management expenses. The
mutual fund industry of Pakistan is in growing stage.

Naim Sipra (2006) Equity Funds outperformed the market and positive
return after deducting costs. The funds also have the potential to add
value due to present lack of diversification indicated by the difference in
Sharpe and Treynor Ratios. The proportion of fund which are able to beat
the market in a given time period is low.

Malkiel and Radisich (2004) no fund was able to beat the market
consistently which indicate the semi strong form of market efficiency.
Index funds are able to beat the market by 100-200 basis points than the
actively managed funds. The major reasons for active funds
underperformance are management fees and trading costs.

Gupta and Gupta (2001) in their Empirical analysis on mutual funds

industry of India investigated the relative shares of four major players in
September 1999. The main players are (1) UTI (2) public Sector banks (3)
Insurance corporation and (4) private sector fund. The total assets under
the management of mutual fund industry stood at Rs.85487 Crore. These
four types consist of 37 players, 11 are in the public sector including UTI
and the remaining ones are the private sector. The UTI alone account for
74 percent, public sector funds is with the share 10.2 percent while the
remaining resources of 15.8 percent are available to the private sector
funds. There are a total of 311 schemes are offered out of the same 182,
142 are Close ended & open ended, respectivly.

In 2002 Research conducted by Bauer, Koedjik, and Otten using an

international database having German, UK and USA ethical funds came
with the stronger proposition & logical ending that the existing empirical

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evidence on US data indicates that ethical screening paves the way to
equaling or slightly reduced performance relative to analogous
unrestricted portfolios. Evidence on the performance of ethical mutual
funds is generally restricted to the US and UK markets. For UK market
four leading papers presented during the last decade. The early
comparative studies of ethical funds to market wide indices like the FT all
are shares index. By means of this methodology Luther, Matatko and
corner (1992) investigated the returns of 15 ethical unit trusts. Their
findings provided some weak substantiation that an ethical fund tends to
out perform general market indices.

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CHAPTER – 3

MUTUAL FUNDS, ECONOMIC INDICATORS AND NET

INFLOW OF FOREIGN PORTFOLIO

3.1 WHAT IS MUTUAL FUND?

A mutual fund is managed by a management company. The management

company is a bank of human resources, considered to be professionally
qualified personnel. The portfolio of mutual fund is managed by a
"Portfolio Manager", whose responsibility is to be invested in, and
satisfies the desire of the investors. While selecting the securities for
investment, these managers analyze economic conditions, industry trends,
government regulations and their impact on the stocks, and forecasts for
the specific stocks to the project the future outcome generated by the
companies. As we all know that the economic and business condition do
not remain constant, so these managers also revise their portfolio with the
passage of time, as the circumstances demand.

3.2 CONCEPT OF MUTUAL FUNDS

The concept is very simple, small investors invest their money into a
common pool or fund and hand over the investment decision to fund
manager/ portfolio manager. This is expected to have several advantages
for the small investors: no more searching for good buys or relying on the
neighborhood sub-broker for advice or even waiting anxiously for the
allotment. All this is taken care of by the cumulative bargaining power of
the fund, which has trained professionals managing it.
Every day, the fund manager/ portfolio manager counts up the value of all
fund's holding, figures out how many shares have been purchased by
shareholders, and then calculates the Net Asset Value (NAV) of the
mutual fund, the price of a single share of the fund on that day. If you

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want to buy shares, you just send the manager your money, and they will
issue new shares for you at the most recent price. If the fund manager is
doing good job, the NAV of the fund will usually get bigger your shares
will be worth more.

The history of mutual fund dates back to 19th century when the process of
pooling money for investing purposes started in Europe in 1868. Similar
practices are reported even in the time of Egyptian and Phoenicians when
they tried to minimize their risk by selling shares to caravans and vessels
(Finance India 1996). The first mutual fund appeared on the floor of
financial market in 1893 when formation of a faculty fund came into being
for Harvard University staff. It was like close-end Mutual Fund. The first
official open end mutual fund took birth on March 21, 1924 when two
broker (Hatherly Foster and Charles Earoyd) pooled their $50,000 as seed
money in Boston, Massachusetts to form an investment trust. This fund
got popularity because of liquidity and ease in use.

3.3 TYPES OF MUTUAL FUNDS

There are two types of mutual funds, which are:

• Open-end mutual funds

• Closed-end mutual funds

OPEN-ENDED MUTUAL FUND:

Open-end mutual funds are those where subscription and redemption of
shares are allowed on a continous basis. The price at which the shares of
open-end funds offered for subscription and redemption is determined by
the NAV after adjusting for any sales load or redemption fee. In Pakistan
there exists thirteen open ended mutual funds; National Investment (Unit)
Trust (NIT) in the public sector and Atlas Income Fund, Crosby Dragon
Fund, Faysal Balanced Growth Fund, Dawood Money Market Fund,
Pakistan Income Fund, Pakistan Stock Market Fund, MetroBank-Pakistan

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Sovereign Fund, Meezan Islamic Fund, Unit Trust of Pakistan, UTP
Income Fund, UTP Islamic Fund and United Money Market Fund in
private sector.

CLOSED-END MUTUAL FUND:

Closed-end mutual funds are those where the shares are initially offered to
the public and are then traded in the secondary market. The trading
usually occurs at a slight discount to the NAV.
Over a period of time, the mutual fund managers have developed a variety
of investment products to cater for the requirement of investors, having
different needs. These include:

• GROWTH FUNDS
• BALANCED FUNDS
• INCOME FUNDS

GROWTH FUNDS
The "growth funds" offer potential for appreciation in share value, while
the current income may be low. The fluctuation in share price may also be
high. Such funds invest in stocks and have tendency to outperform other
funds and other modes of savings over a period of time.

BALANCED FUNDS
The "growth and income funds" or "balanced funds", offer prospects of
both moderate appreciations in share value as well as current income. The
fluctuation in share price may be low. Such funds invest in stocks,
corporate debts and Government paper.

INCOME FUNDS
The "bond fund" or "income funds", offer good current income but very
little potential for growth. Such funds invest in government paper, bonds
issued by municipal or local bodies, corporate debts and in stocks of
utility companies, offering regular return.

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3.4 SOURCES OF PROFIT GENERATION:

A mutual fund can generate profits from three different sources, which
are:

• Dividend
• Capital Gains
• Appreciation of Share Price

Dividend:
Mutual fund generates income from dividends received from other joint
stock companies whose shares the fund holds. A mutual fund uses this
dividend income to distribute dividend to its own stock holders.

Capital Gains:
As discussed earlier the portfolio manager changes the portfolio of the
fund with the passage of the time and also with the changes in economic
and business conditions. So due to the sale and purchase of shares, the
mutual fund generates capital from the sales/ purchase of stocks. The
capital gain generated by the mutual fund is also used to pay dividends to
the investors of the fund.

Appreciation of Share Price:

Mutual funds also increase the wealth/investment of their shareholder
through appreciations of share price of the mutual fund. For example if
the subscription price of a mutual fund is Rs.11.00, and after a period of
seven months the price goes upto Rs.18.00, thus the investor gets a profit
of Rs.7.00 if he sell the mutual fund's shares in the market.

3.5 ADVANTAGES & DISADVANTAGES

Advantages of Mutual Funds:

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 • Mutual Funds substantially lower the investment risk of small
investors through diversification in which funds are spread out into
various sectors, companies, securities as well as entirely different
markets. It is always the objectives of a fund manager to maximize
a funds return for a given level of risk, however the dangers of
"over-diversification" are always prevalent which would inevitably
lead to a reduced return on the portfolio.
• Mutual Funds mobilize the saving of small investors and channel
them into lucrative investment opportunities. As a result, mutual
funds add liquidity to the market. Moreover, given that the funds
are long term investment vehicles, they reduce market volatility by
offering support to scrip prices.
• Mutual Funds are providing the small investor access to the whole
market which individually, would be difficult to achieve.
• The investors save a great deal in transaction cost given that he has
access to a large number of securities by purchasing a single share
of mutual fund.
• The investors can pick and choose a mutual fund to match his
particular needs.

Disadvantages of Mutual Funds:

As such there is no major disadvantage attached to the mutual funds.

However, the possible disadvantages could be:
• Economic and Business Conditions: As the business and economic
conditions do not remain constant, the mutual fund may face some
difficulties in future. Especially if the manager does not shuffle the
investment portfolio with the passage of time, or some other major
unforeseen disaster/event changes the investment scenario.
• Portfolio Managed by Managers: Portfolio of a mutual fund is
managed by the portfolio managers due to which the investor has no
say in the affairs of a mutual fund.

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3.6 HISTORICAL REVIEW OF MUTUAL FUNDS IN PAKISTAN

The history of mutual fund dates back to 19th century when the process of
pooling money for investing purposes started in Europe in 1868. Similar
practices are reported even in the time of Egyptian and Phoenicians when
they tried to minimize their risk by selling shares to caravans and vessels
(Finance India 1996). The first mutual fund appeared on the floor of
financial market in 1893 when formation of a faculty fund came into being
for Harvard University staff. It was like close-end Mutual Fund. The first
official open end mutual fund took birth on March 21, 1924 when two
broker (Hatherly Foster and Charles Earoyd) pooled their $50,000 as seed
money in Boston, Massachusetts to form an investment trust. This fund
got popularity because of liquidity and ease in use.

Mutual Funds world wide assets have crossed the limit of $25.82 trillion
showing a growth of 1.6% p.a. USA is dominant over the whole mutual
fund market with holding of 50% assets ($11.742 trillion) of the world’s
mutual fund market. Mutual Funds of United Kingdom (UK) holds about
$852 Billion assets.

Depreciation of US$ is also a cause of mutual fund’s growth in nominal

form. In China, net assets of mutual fund industry have quadrupled in last
year. Now total assets are about $450 billion. This enormous growth is
due to the change in investor’s behavior that started investment into stock
market by withdrawing their money from traditional banks.
India, the leading economy of South Asia, adopted the concept of
cumulative investment vehicle i.e. Mutual Funds in 1963 by setting up of
first state owned mutual fund “Unit Trust of India (UTI)” by a
parliamentary act in order to support capital market for industrial
purposes. UTI was regulated by Reserve Bank of India (RBI). Monopoly
of UTI remained till it was reorganized in Feb. 2003. From its inception in
1963 to its opening to the private sector and later robust growth, the

P a g e | 19
mutual fund sector in India is a mirror reflection of that in Pakistan as far
as historical developments are concerned, Comparison of India and
Pakistan’s Mutual Fund industry is given in the following table:

Table : 3.1
S/No. INDICATOR PAKISTAN INDIA
1 Net Assets Under Management Rs. 385 billion Rs. 2,318 billion
(2008)
2 Net Assets value / GDP (2007) 4% 8%
3 NAV / Bank Deposits 11% 20%
4 Number of Assets Management 29 41*
Companies
5 Number of Mutual Funds (Schemes 90 5763*
in India)
6 Individual/Retail Investors (%age of 45 45 #
assets ownership
7 Corporate Investors (%age of assets 55 60 #
ownership
*www.mutualfundsindia.com
#
http://in.rediff.com/money/2005/jan/07nri1.htm

Pakistan, one of the emerging economies, started financial innovation in

same period as it was started in India. The decade of 1960 is very
important when Pakistan started thinking to suck corporate and household
saving into a pool, for investing them into more diversified way in stock
exchanges. This concept took birth in 1962 by the formation of National
Investment Trust (NIT) as first mutual fund into financial market (NBFI)
of Pakistan.
NIT is Pakistan’s oldest and largest open-ended mutual fund having
market share of over 27.20% with 19 branches in all Pakistan and UAE. It
was constituted under trust deeds and National Bank of Pakistan as a
trustee. NIT has investment in more than 500 companies out of total 659
in Pakistan listed in Karachi Stock Exchange. It has invested at current
market price in assets of about Rs. 47 billions that makes it the largest
institutional investor in KSE.

P a g e | 20
Number of investors in NIT that holds collectively 749 millions units are
53500 (NIT 2007). Government support was one of the major components
that helped NIT to keep its promises of high returns to investors (NIT
1992) but this policy was discontinued when Pakistan started to follow
economic reforms in 1990s. NIT had equity stakes in many government
owned entities that was privatized following the financial reforms in
Pakistan and made it leader in mutual fund market.

Chronological Development of Mutual Fund Industry in Pakistan

Development of mutual fund industry in Pakistan took place very
sporadically. Important events are as under:

Table 3.2: Milestones in development of mutual fund sector in Pakistan

Years MILESTONES
1962 Birth of National investment Trust – Open Ended
Mutual Fund
1966 Establishment of investment corporation of Pakistan
(ICP) – Close Ended Mutual Fund
1994 Jehangir Siddiqi group launched first private sector
equity based mutual fund
2001 Government decided to wind up of ICP
2002 Management powers of 25 mutual funds under ICP were
sold ABMACO & PICIC
2003 PICIC got management right of state Owned Enterprise
Mutual Fund (EEMF)
2001 Total Net Asset Value of the industry was Ts. 18 billion
2003 – 05 Period of Robust Growth in Mutual Fund
2008 Net assets of mutual fund industry swell to Rs. 385
billion; 90 funds managed by 68 asset management
companies

A mutual fund is a vehicle for pooling together savings of diverse

investors – individuals as well as institutions – to collectively invest these
savings in stocks, bonds and/or money market instruments. It offers
several advantages to investors, particularly retail investors, over taking a
direct exposure in capital and money markets. The expertise and resources
of the fund manager in identifying and selecting investment options is the

P a g e | 21
most important incentive for investing in mutual funds. Besides
professional management, mutual funds offer a diversified investment
portfolio that helps to reduce exposure risks for individual investors and
allows sharing of transaction costs among all investors.
The mutual funds sector has grown rapidly in the last few years ( Figure 1)
and accounted for the largest chunk of 55.3 percent in total assets of the
non‐bank financial sector in FY07. Between FY02 to FY07, net assets of
mutual funds have grown by more than 13 times to reach Rs. 330 billion
by the close of FY07. The average payout of the mutual funds industry
also grew to 18.0 percent in FY07 (22.1 percent in FY06), as illustrated in
Figure 2.

P a g e | 22
The growth in mutual funds in Pakistan is attributable to: (i) liberalization
of the sector; (ii) economic growth and macroeconomic stability that
attracted investors, including foreign investors, to the stock market; (iii)
increased liquidity with institutional investors, which was channelized
into the stock market and mutual funds; (iv) high corporate earnings that
increased the earnings potential for mutual funds; and (v) a buoyant stock
market that provided mutual funds with good returns in the form of capital
gains. Historically, the industry was dominated by public sector funds.
However, creation of an enabling legal framework to allow mutual funds
to be set up in the private sector and transfer of ICP‐managed closed end
funds to two private sector investment advisers in FY03 boosted the
number and size of funds under the management of the private sector,
increased competition and efficiency of the sector and enhanced the

P a g e | 23
quality of fund management. It also provided opportunity to financial
institutions, like banks and brokerage firms, to diversify into fund
management through subsidiaries and associated companies. As may be
seen from Table 3.3, the share of private sector funds in the sector has
grown from 10.0 percent to over 79.2 percent over the last six years or so.

Table 3.3: Struture of Mutual Funds

amount in billion Rupees, share in percent

FY01 FY02 FY03 FY04 FY05 FY06 FY07

Net Assets 24.8 51.6 93.7 125.8 159.9 289.11 330
Share by Ownership
Public Sector 89.6 78.5 52.8 48.5 40.2 31.5 25.7
Private Sector 10.4 21.5 47.2 51.5 59.8 68.5 74.3
Share by type
Open-end Funds 78.1 78.2 73.6 70.1 72.7 82.4 86
Close-end Funds 24.9 21.8 26.4 29.9 27.3 17.6 14
Share by Category
Equity Fund 92.2 81.2 76.5 72.8 63 47.3 40.9
Income Fund 0 6.6 6.4 6.2 10.6 24.4 23.9
Money Market Fund 0 4.6 3.6 3.9 7.3 15 16.2
Balanced Funds 6.7 5.8 10.3 9 7.2 4.6 6.5
Islamic Funds 1.1 1.8 3.2 4.7 5.6 4.9 7.9
Tracker Funds nil nil nil nil 0.6 0.5 0.8
Fund of Funds nil nil nil 0.4 0.5 0.3 0.5
Other nil nil nil nil nil 3 3.3

Source: Annual Audited Accounts of Mutual Funds, SBP and MUFAP

The public sector open ‐end mutual fund, NIT, by its sheer size continues
to have a significant share of 31.0 percent in the net assets of the sector.

As of end‐June FY06, the mutual funds sector comprised of 66 funds with

47 open‐end funds and 19 closed ‐end funds. The number of funds
increased to 95 by end‐FY07. Open‐end funds dominate the sector, as
shown in Table 3.3, due to investors’ preference for ease of exit and the
flexibility this investment option offers. By end‐FY07, the share of open‐
end funds in the net assets of the mutual funds sector was 86.0 percent as
compared to the share of closed‐end funds at 14.0 percent. Closed‐end
mutual funds are more suitable for long ‐term investors. In the absence of

P a g e | 24
the continuous sale and redemption of certificates by a closed ‐end fund,
investors can only exit the fund at the given market price of the
shares/certificates in the stock market, which is generally at a discount to
the NAV per share/certificate. However, lack of redemption pressure has
its advantages for the closed‐end fund, particularly with respect to the
ability to invest in illiquid, but high‐potential small and medium‐sized
companies to earn high returns, optimizing investment of assets by
maintaining low liquidity and saving on marketing and distribution costs.

Given the usefulness of closed‐end funds, necessary mechanisms may be

introduced to facilitate investors who wish to exit a closed ‐end fund in
order to address their primary concern about ease of exit. Internationally,
buy‐back of shares/certificates of a closed‐end fund by its fund manager,
prompted by trading of shares at a certain discount to the NAV, is widely
used to minimize the difference between the market price of
shares/certificates on the stock market and their net asset value (NAV), so
that the secondary market price is not disadvantageous to investors exiting
the closed‐end fund.

An encouraging development in the mutual funds sector is the increasing

diversity of categories of funds offered for public subscription (see type
of Mutual Funds), as also evident from the variety of entrants in the sector
during FY07. By the close of the year, equity funds constituted almost
41.0 percent of the mutual funds sector, income funds constituted 23.9
percent, money market funds had a share of 16.2 percent, balanced funds
6.5 percent, Islamic funds 7.9 percent, while the rest consisted of
miscellaneous types of funds such as tracker funds and fund of funds.
While, equity funds have the largest share in the mutual funds sector in
terms of the number of funds as well as the net assets under management,
however, the large assortment of options for investors is a reflection of
the ability of fund managers to meet the investment needs and risk profile
of a variety of investors.

P a g e | 25
3.7 Types of Mutual Funds in Pakistan
Each mutual fund has specific investment objectives that mould the fund’s
assets, investment options and strategy. At the most basic level, there are
three types of mutual funds: (i) Equity funds, ii) Fixed ‐income funds, and
iii) Money Market funds. All the other kinds of mutual funds are
variations of these three basic types. The characteristics of the various
types of funds are detailed below:

Growth Fund: A mutual fund whose focal aim is to achieve capital

appreciation primarily by investing in growth stocks. In pursuit of large
capital gains, these funds invest in companies with significant earnings or
revenue growth, rather than those with high pay ‐outs. In general, growth
funds are more volatile than other types of funds. Direct correlation with
market is usually greater than 1.
Asset Allocation Fund: This type of mutual fund invests in a variety of
securities in multiple asset classes with the objective of carrying out asset
allocation typically by itself. The rationale is to provide investors with
suitably diversified holdings and consistent returns. Generally, asset
allocation funds are less volatile usually with correlation of almost 1 with
the market.
Money Market Funds: A mutual fund which invests in low risk
securities, for the most part in government securities, CoDs, commercial
paper of companies and other highly liquid and low risk securities. These
funds have inherently low risks. Generally, these funds are least volatile
with weak correlation with the market.
Tracker Fund: This type of fund, as its name suggests, follows the
performance of a particular index. Theoretically, these types of funds are
as volatile as the market with a correlation of unity.
Fund of Funds: A type of mutual fund which invests in other mutual
funds, also known as “multi ‐management” funds. These types of funds
enable investors to achieve a broad diversification and an appropriate

P a g e | 26
asset allocation with investments in a variety of fund categories that all
are wrapped up into one fund. Due to diversification, these funds are less
volatile with moderate correlation with market.
Income Fund: A type of mutual fund that emphasizes current income,
either on a monthly or quarterly basis, as divergent from targeting capital
appreciation. These funds hold a variety of government, municipal and
corporate debt obligations, preferred stock, money market instruments and
dividend paying stocks. Generally, these funds are least volatile with
weak correlation with market.
Balanced Fund: Mutual funds that combine investments in shares, short ‐
term and long‐term bonds in pursuit of income gains and capital
appreciation while avoiding excessive risk. These are also called hybrid
funds. The idea behind this concept is to provide investors with a single
mutual fund that combines income and growth objectives, by investing in
both stocks and bonds. Due to diversification, these funds are less volatile
with moderate correlation with market.
Equity Fund: A mutual fund that invests principally in stocks is called
equity fund. It is also known as a “stock fund”.
This type of fund can be further categorized into two categories, i.e.
domestic and international, depending on the nature of investments of the
fund. Generally, these funds are very volatile with strong correlation with
the market.
Sector Fund: A mutual fund that invests entirely or predominantly in a
specified (single) sector is a sector specific fund. These funds usually
exist in energy, gold, and other precious metals sectors. The risk
associated with these funds depends on the specified sector. These types
of funds are less diversified. The volatility and correlation with market
also depends on the specified sector.
Islamic Funds: A type of fund which entirely invests in Shariah
compliant instruments. Islamic funds exist in almost all the forms
discussed earlier. Each fund invests in its respective areas of interest

P a g e | 27
keeping in view the rules of shariah compliance. The volatility of each
kind of Islamic fund depends on its category and also the relationship with
the market in which it operates.

A significant regulatory development during FY06 was the discontinuation

of SECP’s requirement for asset management companies to seek foreign
collaboration in managing open‐end funds. The condition had been
imposed at the initial stage of development of the mutual funds industry in
Pakistan to facilitate transfer of technical knowledge and expertise from
overseas fund management companies to local fund managers. It was
considerably successful in enabling local asset management companies to
obtain training, know ‐ how and resources from their international
affiliates. The condition was removed once SECP was satisfied with the
pace of development of the mutual funds sector and the abilities of the
asset management companies to manage their respective funds
professionally and proficiently. On the positive side, removal of the
condition for mandatory foreign affiliation has helped to lower barriers to
entry of new fund managers. However, a greater responsibility now lies
with SECP in strengthening its licensing criteria for fund managers,
monitoring their performance and taking appropriate enforcement actions
in order to prevent market abuse. In discharge of this responsibility, SECP
– since August 2005 – requires asset managers and investment advisers to
obtain from credit rating agencies in Pakistan ratings specific to their
fund management quality as well as ratings specific to the performance of
the mutual funds managed by them. The ratings must be disseminated for
public information and disclosed in the accounts and advertisements of
mutual funds and fund managers. SECP has also started inspections of
fund managers, focusing on the quality of their systems and procedures,
subsequent to the close of FY06.

During FY07, SBP allowed mutual funds to make overseas investments up

to 30.0 percent of the aggregate funds mobilized (including foreign

P a g e | 28
currency funds) subject to a cap of US$ 15 million, whichever is lower.5
Prior approval of SBP is required by a mutual fund seeking to invest
outside Pakistan. In order to manage associated risks, SECP generally
requires fund managers to observe certain conditions vis‐à‐vis
international investments. The permission to invest abroad has been
welcomed by the mutual funds sector as it would enable them to diversify
investments outside Pakistan.

Developments in the regulatory and operating environment indicate a

strong potential for the mutual funds sector to continue its growth
momentum albeit the challenges faced by the sector need to be addressed
expeditiously.

3.8 GROSS DOMESTIC PRODUCT – GDP

The gross domestic product (GDP) or gross domestic income (GDI) is a

measure of a country's overall economic output. It is the market value of
all final goods and services made within the borders of a country in a
year. It is often positively correlated with the standard of living, though
its use as a stand-in for measuring the standard of living has come under
increasing criticism and many countries are actively exploring alternative
measures to GDP for that purpose.

GDP can be determined in three ways, all of which should in principle

give the same result. They are the product (or output) approach, the
income approach, and the expenditure approach.

The most direct of the three is the product approach, which sums the
outputs of every class of enterprise to arrive at the total. The expenditure
approach works on the principle that all of the product must be bought by
somebody, therefore the value of the total product must be equal to
people's total expenditures in buying things. The income approach works
on the principle that the incomes of the productive factors ("producers,"

P a g e | 29
colloquially) must be equal to the value of their product, and determines
GDP by finding the sum of all producers' incomes.
Example: the expenditure method:

GDP = private consumption + gross investment + government

spending + (exports − imports), or

In the name "Gross Domestic Product,"

"Gross" means that GDP measures production regardless of the various
uses to which that production can be put. Production can be used for
immediate consumption, for investment in new fixed assets or inventories,
or for replacing depreciated fixed assets. If depreciation of fixed assets is
subtracted from GDP, the result is called the Net domestic product; it is a
measure of how much product is available for consumption or adding to
the nation's wealth. In the above formula for GDP by the expenditure
method, if net investment (which is gross investment minus depreciation)
is substituted for gross investment, then net domestic product is obtained.

"Domestic" means that GDP measures production that takes place within
the country's borders. In the expenditure-method equation given above,
the exports-minus-imports term is necessary in order to null out
expenditures on things not produced in the country (imports) and add in
things produced but not sold in the country (exports).

Economists (since Keynes) have preferred to split the general

consumption term into two parts; private consumption, and public sector
(or government) spending. Two advantages of dividing total consumption
this way in theoretical macroeconomics are:

• Private consumption is a central concern of welfare economics. The

private investment and trade portions of the economy are ultimately

P a g e | 30
 directed (in mainstream economic models) to increases in long-term
private consumption.
• If separated from endogenous private consumption, government
consumption can be treated as exogenous,[citation needed] so that
different government spending levels can be considered within a
meaningful macroeconomic framework.

Gross domestic product comes under the heading of national accounts,

which is a subject in macroeconomics. Economic measurement is called
econometrics.

3.9 DETERMINING GDP

PRODUCTION APPROACH

Usually in this approach the producer units (corporate and unincorporated

enterprises which together form the business sector, "pure" households,
governments and non-profit institutions serving households) of an
economy are classified into classes of industries: agriculture,
construction, manufacturing, etc. Their outputs are estimated largely on
the basis of surveys which businesses fill out, but also the services from
dwellings owned by households are counted towards production. To avoid
"double-counting" in cases where the output of a producer unit is not a
final good or service, but serves as intermediate input (intermediate
consumption) into another producer unit, either only final goods and
services outputs must be counted, or a "value added" approach must be
taken, where what is counted is not the total value output of a producer
unit, but its value added: the difference between the value of its gross
output and the value of its intermediate consumption. Value added is
obtained as a balancing item in the production account of the national
accounts.

Gross Value Added (GVA) = Sum of gross value added by all

P a g e | 31
 producer units = Gross output - intermediate consumption of goods
and services to produce the output.

For market producer sales is usually the largest part of output. But
producer units may also produce output for own final use (own final
consumption or own gross fixed capital formation) or add their output of
goods to their inventories.

Depending on how gross value added has been calculated, it may be

necessary to make an adjustment to it before it can be considered equal to
GDP. This is because GDP is the market value of goods and services – the
price paid by the customer – but the price received by the producer may
be different than this if the government taxes or subsidizes the product.
For example, if there is a sales tax:

Producer's price + sales tax = market price

If taxes and subsidies have not already been computed as part of GVA, we
must compute GDP as:

GDP = GVA + Taxes on products - Subsidies on products

EXPENDITURE APPROACH

In contemporary economies, most things produced are produced for sale,

and sold. Therefore, measuring the total expenditure of money used to buy
things is a way of measuring production. This is known as the expenditure
method of calculating GDP. Note that if you knit yourself a sweater, it is
production but does not get counted as GDP because it is never sold.
Sweater-knitting is a small part of the economy, but if one counts some
major activities such as child-rearing (generally unpaid) as production,
GDP ceases to be an accurate indicator of production.

P a g e | 32
COMPONENTS OF GDP BY EXPENDITURE

GDP (Y) is a sum of Consumption (C), Investment (I), Government

Spending (G) and Net Exports (X - M).

Y = C + I + G + (X − M)

Here is a description of each GDP component:

• C (consumption) is normally the largest GDP component in the

economy, consisting of private (household final consumption
expenditure) in the economy. These personal expenditures fall under
one of the following categories: durable goods, non-durable goods,
and services. An example includes food, rent, jewelry, gasoline, and
medical expenses but does not include the purchase of new housing.
• I (investment) include business investment in equipments for
example and does not include exchanges of existing assets.
Examples include construction of a new mine, purchase of
[software], or purchase of machinery and equipment for a factory.
Spending by households (not government) on new houses is also
included in Investment. In contrast to its colloquial meaning,
'Investment' in GDP does not mean purchases of financial products.
Buying financial products is classed as 'saving', as opposed to
investment. This avoids double-counting: if one buys shares in a
company, and the company uses the money received to buy plant,
equipment, etc., the amount will be counted toward GDP when the
company spends the money on those things; to also count it when
one gives it to the company would be to count two times an amount
that only corresponds to one group of products. Buying bonds or
stocks is a swapping of deeds, a transfer of claims on future
production, not directly an expenditure on products.

P a g e | 33
 • G (government spending) is the sum of government expenditures
on final goods and services. It includes salaries of public servants,
purchase of weapons for the military, and any investment
expenditure by a government. It does not include any transfer
payments, such as social security or unemployment benefits.
• X (exports) represents gross exports. GDP captures the amount a
country produces, including goods and services produced for other
nations' consumption, therefore exports are added.
• M (imports) represents gross imports. Imports are subtracted since
imported goods will be included in the terms G, I, or C, and must
be deducted to avoid counting foreign supply as domestic.

A fully equivalent definition is that GDP (Y) is the sum of final

consumption expenditure (FCE), gross capital formation (GCF), and net
exports (X - M).

Y = FCE + G CF + (X − M)

FCE can then be further broken down by three sectors (households,

governments and non-profit institutions serving households) and GCF by
five sectors (non-financial corporations, financial corporations,
households, governments and non-profit institutions serving households).
The advantage of this second definition is that expenditure is
systematically broken down, firstly, by type of final use (final
consumption or capital formation) and, secondly, by sectors making the
expenditure, whereas the first definition partly follows a mixed
delimitation concept by type of final use and sector.

Note that C, G, and I are expenditures on final goods and services;

expenditures on intermediate goods and services do not count.
(Intermediate goods and services are those used by businesses to produce
other goods and services within the accounting year)

P a g e | 34
According to the U.S. Bureau of Economic Analysis, which is responsible
for calculating the national accounts in the United States, :In general, the
source data for the expenditures components are considered more reliable
than those for the income components.

EXAMPLES OF GDP COMPONENT VARIABLES

C, I, G, and NX (net exports): If a person spends money to renovate a

hotel to increase occupancy rates, the spending represents private
investment, but if he buys shares in a consortium to execute the
renovation, it is saving. The former is included when measuring GDP (in
I), the latter is not. However, when the consortium conducted its own
expenditure on renovation, that expenditure would be included in GDP.

If a hotel is a private home, spending for renovation would be measured as

consumption, but if a government agency converts the hotel into an office
for civil servants, the spending would be included in the public sector
spending, or G.

If the renovation involves the purchase of a chandelier from abroad, that

spending would be counted as C, G, or I (depending on whether a private
individual, the government, or a business is doing the renovation), but
then counted again as an import and subtracted from the GDP so that GDP
counts only goods produced within the country.

If a domestic producer is paid to make the chandelier for a foreign hotel,

the payment would not be counted as C, G, or I, but would be counted as
an export.

P a g e | 35
INCOME APPROACH

Another way of measuring GDP is to measure total income. If GDP is

calculated this way it is sometimes called Gross Domestic Income (GDI),
or GDP (I). GDI should provide the same amount as the expenditure
method described above. (By definition, GDI = GDP. In practice,
however, measurement errors will make the two figures slightly off when
reported by national statistical agencies.)

Total income can be subdivided according to various schemes, leading to

various formulae for GDP measured by the income approach. A common
one is:

GDP = compensation of employees + gross operating surplus +

gross mixed income + taxes less subsidies on production and
imports
GDP = COE + GOS + GMI + T P & M - SP & M

• Compensation of employees (COE) measures the total

remuneration to employees for work done. It includes wages and
salaries, as well as employer contributions to social security and
other such programs.
• Gross operating surplus (GOS) is the surplus due to owners of
incorporated businesses. Often called profits, although only a subset
of total costs is subtracted from gross output to calculate GOS.
• Gross mixed income (GMI) is the same measure as GOS, but for
unincorporated businesses. This often includes most small
businesses.

P a g e | 36
The sum of COE, GOS and GMI is called total factor income; it is the
income of all of the factors of production in society. It measures the value
of GDP at factor (basic) prices. The difference between basic prices and
final prices (those used in the expenditure calculation) is the total taxes
and subsidies that the government has levied or paid on that production.
So adding taxes less subsidies on production and imports converts GDP at
factor cost to GDP (I).

Total factor income is also sometimes expressed as:

Total factor income = Employee compensation + Corporate profits +

Proprieter’s income + Rental income + Net
interest

Yet another formula for GDP by the income method is:

GDP = R + I + P + SA + W

where R : rents
I : interests
P : profits
SA : statistical adjustments (corporate income taxes, dividends,
undistributed corporate profits)
W : wages
Note the mnemonic, "ripsaw".

==a "production boundary" that delimits what will be counted as GDP.

"One of the fundamental questions that must be addressed in preparing the

national economic accounts is how to define the production boundary – that
is, what parts of the myriad human activities are to be included in or
excluded from the measure of the economic production."

P a g e | 37
All output for market is at least in theory included within the boundary.
Market output is defined as that which is sold for "economically
significant" prices; economically significant prices are "prices which have
a significant influence on the amounts producers are willing to supply and
purchasers wish to buy." An exception is that illegal goods and services
are often excluded even if they are sold at economically significant prices
(Australia and the United States exclude them).

This leaves non-market output. It is partly excluded and partly included.

First, "natural processes without human involvement or direction" are
excluded. Also, there must be a person or institution that owns or is
entitled to compensation for the product. An example of what is included
and excluded by these criteria is given by the United States' national
accounts agency: "the growth of trees in an uncultivated forest is not
included in production, but the harvesting of the trees from that forest is
included."

Within the limits so far described, the boundary is further constricted by

"functional considerations." The Australian Bureau for Statistics explains
this: "The national accounts are primarily constructed to assist
governments and others to make market-based macroeconomic policy
decisions, including analysis of markets and factors affecting market
performance, such as inflation and unemployment." Consequently,
production that is, according to them, "relatively independent and isolated
from markets," or "difficult to value in an economically meaningful way"
[i.e., difficult to put a price on] is excluded. Thus excluded are services
provided by people to members of their own families free of charge, such
as child rearing, meal preparation, cleaning, transportation, entertainment
of family members, emotional support, care of the elderly. Most other
production for own (or one's family's) use is also excluded, with two
notable exceptions which are given in the list later in this section.

P a g e | 38
Non market outputs that are included within the boundary are listed
below. Since, by definition, they do not have a market price, the compliers
of GDP must impute a value to them, usually either the cost of the goods
and services used to produce them, or the value of a similar item that is
sold on the market.

• Goods and services provided by governments and non-profit

organizations free of charge or for economically insignificant prices
are included. The value of these goods and services is estimated as
equal to their cost of production.
• Goods and services produced for own-use by businesses are
attempted to be included. An example of this kind of production
would be a machine constructed by an engineering firm for use in
its own plant.
• Renovations and upkeep by an individual to a home that she owns
and occupies are included. The value of the upkeep is estimated as
the rent that she could charge for the home if she did not occupy it
herself. This is the largest item of production for own use by an
individual (as opposed to a business) that the compilers include in
GDP.
• Agricultural production for consumption by oneself or one's
household is included.
• Services (such as chequeing-account maintenance and services to
borrowers) provided by banks and other financial institutions
without charge or for a fee that does not reflect their full value have
a value imputed to them by the compilers and are included. The
financial institutions provide these services by giving the customer
a less advantageous interest rate than they would if the services
were absent; the value imputed to these services by the compilers is
the difference between the interest rate of the account with the
services and the interest rate of a similar account that does not have

P a g e | 39
 the services. According to the United States Bureau for Economic
Analysis, this is one of the largest imputed items in the GDP.

GROSS DOMESTC PRODUCT vs. GROSS NATIONAL PRODUCT

GDP can be contrasted with gross national product (GNP) or gross

national income (GNI). The difference is that GDP defines its scope
according to location, while GNP defines its scope according to
ownership. GDP is product produced within a country's borders; GNP is
product produced by enterprises owned by a country's citizens. The two
would be the same if all of the productive enterprises in a country were
owned by its own citizens, but foreign ownership makes GDP and GNP
non-identical. Production within a country's borders, but by an enterprise
owned by somebody outside the country, counts as part of its GDP but not
its GNP; on the other hand, production by an enterprise located outside
the country, but owned by one of its citizens, counts as part of its GNP
but not its GDP.

To take the United States as an example, the U.S.'s GNP is the value of
output produced by American-owned firms, regardless of where the firms
are located.

Gross national income (GNI) equals GDI plus income receipts from the
rest of the world minus income payments to the rest of the world.

In 1991, the United States switched from using GNP to using GDP as its
primary measure of production. The relationship between United States
GDP and GNP is shown in table 1.7.5 of the National Income and Product
Accounts.

International standards
The international standard for measuring GDP is contained in the book
System of National Accounts (1993), which was prepared by

P a g e | 40
representatives of the International Monetary Fund, European Union,
Organization for Economic Co-operation and Development, United
Nations and World Bank. The publication is normally referred to as
SNA93 to distinguish it from the previous edition published in 1968
(called SNA68)

SNA93 provides a set of rules and procedures for the measurement of

national accounts. The standards are designed to be flexible, to allow for
differences in local statistical needs and conditions.

National measurement
Within each country GDP is normally measured by a national government
statistical agency, as private sector organizations normally do not have
access to the information required (especi ally information on expenditure
and production by governments).

Interest rates

Net interest expense is a transfer payment in all sectors except the

financial sector. Net interest expenses in the financial sector are seen as
production and value added and are added to GDP.

ADJUSTMENTS TO GDP

When comparing GDP figures from one year to another, it is desirable to

compensate for changes in the value of money – inflation or deflation. The
raw GDP figure as given by the equations above is called the nominal, or
historical, or current, GDP. To make it more meaningful for year-to-year
comparisons, it may be multiplied by the ratio between the value of money
in the year the GDP was measured and the value of money in some base
year. For example, suppose a country's GDP in 1990 was $100 million and
its GDP in 2000 was $300 million; but suppose that inflation had halved
the value of its currency over that period. To meaningfully compare its

P a g e | 41
2000 GDP to its 1990 GDP we could multiply the 2000 GDP by one-half,
to make it relative to 1990 as a base year. The result would be that the
2000 GDP equals $300 million x one-half = $150 million, in 1990
monetary terms. We would see that the country's GDP had, realistically,
increased by 1.5 times over that period, not 3 times, as it might appear
from the raw GDP data. The GDP adjusted for changes in money-value in
this way is called the real, or constant, GDP.

The factor used to convert GDP from current to constant values in this
way is called the GDP deflator. Unlike the Consumer price index, which
measures inflation (or deflation – rarely!) in the price of household
consumer goods, the GDP deflator measures changes in the prices all
domestically produced goods and services in an economy – including
investment goods and government services, as well as household
consumption goods.

Constant-GDP figures allow us to calculate a GDP growth rate, which tells

us how much a country's production has increased (or decreased, if the
growth rate is negative) compared to the previous year.

Real GDP growth rate for year n = [(Real GDP in year n) - (Real
GDP in year n - 1)]/ (Real GDP in year n - 1)

Another thing that it may be desirable to compensate for is population

growth. If a country's GDP doubled over some period but its population
tripled, the increase in GDP may not be deemed such a great
accomplishment: the average person in the country is producing less than
they were before. Per-capita GDP is the measure compensated for
population growth.

P a g e | 42
CROSS-BORDER COMPARISON

The level of GDP in different countries may be compared by converting

their value in national currency according to either the current currency
exchange rate, or the purchase power parity exchange rate.

• Current currency exchange rate is the exchange rate in the

international currency market.
• Purchasing power parity exchange rate is the exchange rate based
on the purchasing power parity (PPP) of a currency relative to a
selected standard (usually the United States dollar).

The ranking of countries may differ significantly based on which method

is used.

• The current exchange rate method converts the value of goods and
services using global currency exchange rates. The method can offer
better indications of a country's international purchasing power and
relative economic strength. For instance, if 10% of GDP is being
spent on buying hi-tech foreign arms, the number of weapons
purchased is entirely governed by current exchange rates, since
arms are a traded product bought on the international market. There
is no meaningful 'local' price distinct from the international price
for high technology goods.
• The purchasing power parity method accounts for the relative
effective domestic purchasing power of the average producer or
consumer within an economy. The method can provide a better
indicator of the living standards of less developed countries,
because it compensates for the weakness of local currencies in the
international markets. For example, India ranks 12th by nominal
GDP, but fourth by PPP. The PPP method of GDP conversion is
more relevant to non-traded goods and services.

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There is a clear pattern of the purchasing power parity method decreasing
the disparity in GDP between high and low income (GDP) countries, as
compared to the current exchange rate method. This finding is called the
Penn effect.

For more information, see Measures of national income and output.

STANDARD OF LIVING AND GDP

GDP per capita is not a measurement of the standard of living in an

economy. However, it is often used as such an indicator, on the rationale
that all citizens would benefit from their country's increased economic
production. Similarly, GDP per capita is not a measure of personal
income. GDP may increase while incomes for the majority of a country's
citizens may even decrease or change disproportional. For example, in the
US from 1990 to 2006 the earnings (adjusted for inflation) of individual
workers, in private industry and services, increased by less than 0.5% per
year while GDP (adjusted for inflation) increased about 3.6% per year
over the same period.

The major advantage of GDP per capita as an indicator of standard of

living is that it is measured frequently, widely and consistently. It is
measured frequently in that most countries provide information on GDP
on a quarterly basis, which allows a user to spot trends regularly. It is
measured widely in that some measure of GDP is available for almost
every country in the world, allowing comparisons to be made between
countries. It is measured consistently in that the technical definition of
GDP is relatively consistent among countries.

The major disadvantage is that it is not, strictly speaking, a measure of

standard of living. GDP is intended to be a measure of particular types of
economic activity within a particular country. Nothing about the
definition of GDP suggests it is necessarily a measure of standard of

P a g e | 44
living. For instance, in an extreme example, a country which exported 100
per cent of its production and imported nothing would still have a high
GDP, but a very poor standard of living.

The argument in favor of using GDP is not that it is a good indicator of

the standard of living, but that, all other things being equal, the standard
of living tends to increase when GDP per capita increases. As such, GDP
can be a proxy for the standard of living, rather than a direct measure. The
sometimes use of GDP per capita as a proxy of labor productivity is also
problematic.

LIMITATIONS OF GDP TO JUDGE THE HEALTH OF AN ECONOMY

GDP is widely used by economists to gauge the health of an economy, as

its variations are relatively quickly identified. However, its value as an
indicator for the standard of living is considered to be limited. Not only
that, but if the aim of economic activity is to produce ecologically
sustainable increases in the overall human standard of living, GDP is a
perverse measurement; it treats loss of ecosystem services as a benefit
instead of a cost. Other criticisms of how the GDP is used include:

• Wealth distribution – GDP does not take disparity in incomes

between the rich and poor into account. However, numerous Nobel-
prize winning economists have disputed the importance of income
inequality as a factor in improving long-term economic growth. In
fact, short term increases in income inequality may even lead to
long term decreases in income inequality. See income inequality
metrics for discussion of a variety of inequality-based economic
measures.
• Non-market transactions – GDP excludes activities that are not
provided through the market, such as household production and
volunteer or unpaid services. As a result, GDP is understated.

P a g e | 45
 Unpaid work conducted on Free and Open Source Software (such as
Linux) contributes nothing to GDP, but it was estimated that it
would have cost more than a billion US dollars for a commercial
company to develop. Also, if Free and Open Source Software
became identical to its proprietary software counterparts, and the
nation producing the propriety software stops buying proprietary
software and switches to Free and Open Source Software, then the
GDP of this nation would reduce, however there would be no
reduction in economic production or standard of living. The work of
New Zealand economist Marilyn Waring has highlighted that if a
concerted attempt to factor in unpaid work were made, then it would
in part undo the injustices of unpaid (and in some cases, slave)
labor, and also provide the political transparency and accountability
necessary for democracy. Shedding some doubt on this claim,
however, is the theory that won economist Douglass North the
Nobel Prize in 1993. North argued that the creation and
strengthening of the patent system, by encouraging private
invention and enterprise, became the fundamental catalyst behind
the Industrial Revolution in England.
• Underground economy – Official GDP estimates may not take into
account the underground economy, in which transactions
contributing to production, such as illegal trade and tax-avoiding
activities, are unreported, causing GDP to be underestimated.
• Non-monetary economy – GDP omits economies where no money
comes into play at all, resulting in inaccurate or abnormally low
GDP figures. For example, in countries with major business
transactions occurring informally, portions of local economy are not
easily registered. Bartering may be more prominent than the use of
money, even extending to services (I helped you build your house
ten years ago, so now you help me).
• GDP also ignores subsistence production.

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• Quality improvements and inclusion of new products – By not
adjusting for quality improvements and new products, GDP
understates true economic growth. For instance, although computers
today are less expensive and more powerful than computers from
the past, GDP treats them as the same products by only accounting
for the monetary value. The introduction of new products is also
difficult to measure accurately and is not reflected in GDP despite
the fact that it may increase the standard of living. For example,
even the richest person from 1900 could not purchase standard
products, such as antibiotics and cell phones, that an average
consumer can buy today, since such modern conveniences did not
exist back then.
• What is being produced – GDP counts work that produces no net
change or that results from repairing harm. For example, rebuilding
after a natural disaster or war may produce a considerable amount
of economic activity and thus boost GDP. The economic value of
health care is another classic example—it may raise GDP if many
people are sick and they are receiving expensive treatment, but it is
not a desirable situation. Alternative economic estimates, such as
the standard of living or discretionary income per capita try to
measure the human utility of economic activity. See uneconomic
growth.
• Externalities – GDP ignores externalities or economic beds such as
damage to the environment. By counting goods which increase
utility but not deducting beds or accounting for the negative effects
of higher production, such as more pollution, GDP is overstating
economic welfare. The Genuine Progress Indicator is thus proposed
by ecological economists and green economists as a substitute for
GDP, supposing a consensus on relevant data to measure "progress".
In countries highly dependent on resource extraction or with high
ecological footprints the disparities between GDP and GPI can be

P a g e | 47
 very large, indicating ecological overshoot. Some environmental
costs, such as cleaning up oil spills are included in GDP.
• Sustainability of growth – GDP is not a tool of economic
projections, which would make it subjective, it is just a
measurement of economic activity. That is why it does not measure
what is considered the sustainability of growth. A country may
achieve a temporarily high GDP by over-exploiting natural
resources or by misallocating investment. For example, the large
deposits of phosphates gave the people of Nauru one of the highest
per capita incomes on earth, but since 1989 their standard of living
has declined sharply as the supply has run out. Oil-rich states can
sustain high GDPs without industrializing, but this high level would
no longer be sustainable if the oil runs out. Economies experiencing
an economic bubble, such as a housing bubble or stock bubble, or a
low private-saving rate tend to appear to grow faster owing to
higher consumption, mortgaging their futures for present growth.
Economic growth at the expense of environmental degradation can
end up costing dearly to clean up.
• One main problem in estimating GDP growth over time is that the
purchasing power of money varies in different proportion for
different goods, so when the GDP figure is deflated over time, GDP
growth can vary greatly depending on the basket of goods used and
the relative proportions used to deflate the GDP figure. For
example, in the past 80 years the GDP per capita of the United
States if measured by purchasing power of potatoes, did not grow
significantly. But if it is measured by the purchasing power of eggs,
it grew several times. For this reason, economists comparing
multiple countries usually use a varied basket of goods.
• Cross-border comparisons of GDP can be inaccurate as they do not
take into account local differences in the quality of goods, even
when adjusted for purchasing power parity. This type of adjustment

P a g e | 48
 to an exchange rate is controversial because of the difficulties of
finding comparable baskets of goods to compare purchasing power
across countries. For instance, people in country A may consume
the same number of locally produced apples as in country B, but
apples in country A are of a more tasty variety. This difference in
material well being will not show up in GDP statistics. This is
especially true for goods that are not traded globally, such as
housing.
• Transfer pricing on cross-border trades between associated
companies may distort import and export measures.
• As a measure of actual sale prices, GDP does not capture the
economic surplus between the price paid and subjective value
received, and can therefore underestimate aggregate utility.

CHAPTER – 4

RESEARCH METHODOLGY

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This chapter addresses the approach to the study. It provides an
explanation of the research design, details regarding the variables to be
examined and means of data collection. The purpose of this research was
to check the performance of mutual funds industry of Pakistan during the
period 1996 – 97 to 2006 – 07.

To asses the performance of Pakistan mutual fund industry we measured

the relationship between mutual funds and GDP, GNP, Domestic Savings
and net inflow of foreign portfolio investment. We take mutual fund as
dependent variable and GDP, GNP, Domestic Saving and Net inflow of
foreign portfolio as independent variables.
In order to empirically extract the relationship between dependent and
independent variables we adopted the following methodology.
4.1 DATA
This study is purely based on Secondary Data collected on annual basis
from different mutual funds in Pakistan. This has taken from different
sources which includes the official Web Sites of Mutual Funds
Association of Pakistan, MUFAP, SBP annual Report (2006-07), Planning
and Development Commission of Pakistan.
4.2 METHODOLOGY
The result is determined by Regression, i.e. Co-efficient of correlation (r)
and co-efficient of determination (r 2 ).
To measure the significance of the model is to measure the contribution of
the independent variables i.e. Gross Domestic Product, Gross National
Product, Domestic Saving and Net Inflow of foreign Portfolio investment
in predicting the dependant variable i.e. mutual fund. To accomplish this,
coefficient of determination (r 2 ) is calculated. The rule of thumb for the
coefficient of determination is such that 0 < r 2 < 1 and demonstrates the
strength of the linear alliance between independent variables and
dependent variables.

4.3 CRITERIA FOR VARIABLE SELECTION

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We have selected GDP, GNP, domestic saving and Net Inflow of Foreign
Portfolio Investment as independent variables because of following
reasons.
1. Availability of Data
Since the web sites of SBP & Ministry of Finance are instantly
accessible contain the historically reliable & refined secondary data
related to GDP, GNP & Domestic Savings. While the official Web Page
of MUFAP has updated record of NIFP. Thus the data regarding these
variables are available through many sources, that’s why we have
selected these variables with a sole research objective to reach a
logical & unbiased conclusion.
2. Shortage of Time
The efficient utilization of scarced time resources was another factor to
select variables whose availability, processing, refinement require
lesser time
3. Quantitative nature of Data
Since the research is of quantitative nature & needing more
precision & accuracy which can tested, verified, evaluated through
many of the available statistaical tools.

P a g e | 51
CHAPTER – 5
DATA ANALYSIS

This part of research provides analysis of the data. The data is analyzed
through econometric techniques. A model was specified and estimated
using SPSS.

We have analyzed Mutual Fund as dependent variable with GDP, GNP,

Gross Domestic Saving and Net inflow of foreign portfolio as independent
variables.

The results are given below

5.1 Mutual Fund and GDP

Regression
b
Variables Entered/Removed

Variables Variables
Model Entered Removed Method
1 GDPa . Enter
a. All requested variables entered.
b. Dependent Variable: M.F

Model Summary

Adjusted Std. Error of

Model R R Square R Square the Estimate
1 .943 a .889 .875 21.1284
a. Predictors: (Constant), GDP

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 ANOVAb

Sum of
Model Squares df Mean Square F Sig.
1 Regression 28512.085 1 28512.085 63.870 .000 a
Residual 3571.281 8 446.410
Total 32083.366 9
a. Predictors: (Constant), GDP
b. Dependent Variable: M.F

Coefficientsa

Standardi
zed
Unstandardized Coefficien
Coefficients ts
Model B Std. Error Beta t Sig.
1 (Constant) -341.315 50.771 -6.723 .000
GDP 1.061E-04 .000 .943 7.992 .000
a. Dependent Variable: M.F

Interpretation

Model:

M.F = -341.315 + 0.943 GDP

The above regression shows the relationship between mutual fund and
GDP. It is evident from value of R, i.e. 94 %, which means the both the
variables mutual fund and GDP are 94 % related. Also the model is
explaining the scenario by 88.9 %. As for as the significance is concerned
both t & F values are significant, i.e. F = 63.870 & t = 7.992

5.2 Mutual Funds and GNP

Regression

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 b
Variables Entered/Removed

Variables Variables
Model Entered Removed Method
1 GNPa . Enter
a. All requested variables entered.
b. Dependent Variable: M.F

Model Summary

Adjusted Std. Error of

Model R R Square R Square the Estimate
1 .926 a .857 .839 23.9491
a. Predictors: (Constant), GNP

ANOVAb

Sum of
Model Squares df Mean Square F Sig.
1 Regression 27494.903 1 27494.903 47.937 .000 a
Residual 4588.463 8 573.558
Total 32083.366 9
a. Predictors: (Constant), GNP
b. Dependent Variable: M.F

Coefficientsa

Standardi
zed
Unstandardized Coefficien
Coefficients ts
Model B Std. Error Beta t Sig.
1 (Constant) -79.796 21.688 -3.679 .006
GNP 2.706E-05 .000 .926 6.924 .000
a. Dependent Variable: M.F

Interpretation:

Model:

M.F = -79.796 + 0.926 GNP

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This regression result shows the relationship between mutual fund and
GNP. It is much clear from the value of R, which show the relatedness of
both the variables that these variables are 92.6 % related. The above
model describes the scenario by 85.7%. If we talk about the significance
so both the variables t & F values are significant.

5.3 Mutual Funds and Gross Domestic Savings

Regression

b
Variables Entered/Removed

Variables Variables
Model Entered Removed Method
1 GDSa . Enter
a. All requested variables entered.
b. Dependent Variable: M.F

Model Summary

Adjusted Std. Error of

Model R R Square R Square the Estimate
1 .830 a .688 .649 35.3679
a. Predictors: (Constant), GDS

ANOVAb

Sum of
Model Squares df Mean Square F Sig.
1 Regression 22076.286 1 22076.286 17.649 .003 a
Residual 10007.080 8 1250.885
Total 32083.366 9
a. Predictors: (Constant), GDS
b. Dependent Variable: M.F

P a g e | 55
 Coefficientsa

Standardi
zed
Unstandardized Coefficien
Coefficients ts
Model B Std. Error Beta t Sig.
1 (Constant) -422.861 115.697 -3.655 .006
GDS 1.269E-03 .000 .830 4.201 .003
a. Dependent Variable: M.F

Interpretation:

Model:

M.F = -422.861 + 0.830 GDS

Talking about the above regression result, it shows the mutual fund and
domestic saving relationship. From the value of R, i.e. 83%, it is clear the
both the variables mutual fund and domestic savings are related to 83%.
The scenario is 68 % explain form the model. Also both the variables t &
F are significant, as for as the significant is concerned. i.e. t = 4.201 and
F = 17.649

5.4 Mutual Funds and Net Inflow of Foreign Portfolio

Regression

b
Variables Entered/Removed

Variables Variables
Model Entered Removed Method
1 NIFPa . Enter
a. All requested variables entered.
b. Dependent Variable: M.F

P a g e | 56
 Model Summary

Adjusted Std. Error of

Model R R Square R Square the Estimate
1 .633 a .401 .326 49.0315
a. Predictors: (Constant), NIFP

ANOVAb

Sum of
Model Squares df Mean Square F Sig.
1 Regression 12850.648 1 12850.648 5.345 .050 a
Residual 19232.718 8 2404.090
Total 32083.366 9
a. Predictors: (Constant), NIFP
b. Dependent Variable: M.F

Coefficientsa

Standardi
zed
Unstandardized Coefficien
Coefficients ts
Model B Std. Error Beta t Sig.
1 (Constant) 37.426 18.536 2.019 .078
NIFP .259 .112 .633 2.312 .050
a. Dependent Variable: M.F

Interpretation:

Model:

MF = 37.426 + 0.633 NIFP

The above regression result shows the mutual fund and net inflow of
foreign portfolio relationship. The value of R, i.e. 63%, shows the
relationship between mutual fund and NIFP that both the variables are
related. And if we talk about the model, so it explaining the scenario by
40%, and the significance of both the variables so it is clear from the
values the both the variables are significant.

P a g e | 57
CHAPTER – 6
FINDINGS & CONCLUSION

I n th is chapter the res earcher dis cuss ed the findings of the s tudy an d
co n cluded thes e findings .

The researcher analyzed four independent variables and developed a

model for these variables in order to see its impact on dependent variable
i.e. Mutual Fund.

6.1 FINDINGS

The study found that:

The mutual fund and GNP, GDP, gross domestic savings and net inflow of
foreign portfolio are very much related and have positive relation between
them, according to the data analysis results.

• The mutual fund and GDP are 94% related, also shows the
significance of both the variables that t & F are significant. The
value of t = 6.924 while value of F = 47.937 which shows the
significance. The coefficient of determination is 88.9% which
explaining the model. There is a positive relation between Mutual
Fund and GDP, as 1 unit increase in GDP increases 0.633 unit
increase in mutual fund as well as in the absence of GDP, the
mutual fund loose it value.
• The mutual fund and GNP are 92.6% related, the t & F values shows
the significance i.e. t = 6.924, F = 47.937. The r 2 which is
coefficient of determination explaining the scenario by 85.7%. Here
also the relation between mutual fund and GNP is positive and 1
unit increase in GNP increases 0.926 units increase in mutual fund.
Here also the absence of GNP, the mutual fund will loose it value.
• The variables mutual fund which is dependent and gross domestic

P a g e | 58
 savings which is independent both are related 83%, and as for as the
significance is concerned so both t & F are significant, i.e. t = 4.201
& F =17.649. The coefficient of determination r 2 in case of mutual
fund and gross domestic savings explaining the situation by 68%. In
this case the relation is also positive. That 1 unit increase in GDS
will increase mutual fund by 0.830 units.
• In case of mutual fund and net inflow of foreign portfolio, the
relation is positive and both of these variables are related by 63%
and if we talk about the “t” & “F” so both the values are
significance, i.e. t = 2.312 & F = 5.345. The model is explaining the
scenario by 40%.
6.2 CONCLUSION

We have chosen four independent variables and statistically analyzed the

their relationship (positive or negative) on the 5 t h dependent variable i.e.
Mutual fund during the period in question via the coefficient of
correlation and coefficient of determination. The statistically significant
results exhibits that all the four independent variables have positive
relationship with the Mutual Fund, which implies that due to any amplify
in Mutual Fund Industry, the financial performance also improved. This
paper analyzed the Coefficient of Determination to quantify, how much
change in Mutual Fund can be explained by using the Independent
variables or how much these Independent variables add to the changes in
dependant variable.

The linear regression was used to compute the relationship between the
dependant and independent variables. First regression was carried out in
between Mutual Fund and GDP. The values of “t” & “F” show the
significance level between these variables. The correlation of Mutual
Fund and Domestic Saving are also tested and established that the result
are statistically significant at the preferred level of significance which
implies that these two variables have positive relationship with the Mutual

P a g e | 59
Fund. Also in the case of Mutual Fund and GNP the results are significant
from the values of “t” & “F”. While in the case of Mutual Fund and Net
Inflow of Foreign Portfolio Investment the result indicates that the
computed value of “t” & “F” are also statistically significant. This
Phenomenon also scientifically implies that majority of the foreign
portfolio investment is at one hand bound to a small number of shares in
the stock market or the foreign portfolio investors do not perceive
Pakistani financial markets as preferred choice for investment &
diversification to minimize risk. This may also point to the fact & causal
relationships of inconsistency in monitory & fiscal policies, manipulation
by the regulator, extremely volatile capital market besides the fluctuating
geo- political conditions. Pakistan may not be a striking choice of
investment prospects to the foreign portfolio managers.

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